Guangdong province is calling for the cancellation of a decades-long property pre-sale system that has played a primary role in supporting China’s real estate developers.

The provincial branch of China’s Ministry of Housing and Urban-Rural Development (MOHURD) issued a notice last week to solicit developers’ views on phasing out the system, according to an account state-owned news site thepaper.cn Since 1994, China has allowed home builders to receive the entire sales proceeds up front before the construction completes, which they then use to finance further land purchases and developments.

The notice indicated that the current system creates risks to the economy from unfinished developments, unruly sales activities and unfair competition. The housing regulator recommended that the high levels of developer leverage bred by the system should be reduced by gradually moving away from pre-sales.

Regulatory Threat Hits Developer Stocks

Titled “Emergency Notice on Opinions Regarding Pre-sales Permits for Commodity Houses,” the notice is also said to have been circulated by local governments in Hubei, Sichuan, Jiangsu, Henan, and Liaoning provinces, in addition to Guangdong.

In response to the regulatory news, shares of the Hong Kong-listed Chinese developers slumped on Monday just before China’s mid-autumn festival holiday. Country Garden Holdings Co, whose meteoric growth relied largely on pre-sales, led with a share price drop of 5.57 percent. Shimao Property fell 5.22 percent, followed by CR Land’s 4.83 percent, while Sunac lost 4.02 percent and Guangzhou-based Agile Group declined 3.88 percent.

The equity impact of the potential policy overhaul came as investors feared that, if implemented, the end of pre-sales would place further strain on China’s debt-laden developers. Analysts estimate that mainland-based developers are collectively facing a record $23 billion maturity wall in the first quarter of 2019, after Chinese authorities began reducing approvals for new bond sales and restricting borrowing from shadow banks earlier this year.

The Chinese media reacted to the news with caution. An article in the Beijing News urged the authority not to act with haste, while the official Guangzhou Daily noted that the changes under consideration are still at the opinion-gathering stage.

Developer Cautions Against Cutting 33% of Funding

Ouyang Jie, senior vice president of Shanghai-listed developer Seazen Holdings, said switching from a pre-sale system to sales of existing homes is an irreversible though challenging process, and that any such change would need to be carefully implemented.

The real estate developer cited data from China’s National Bureau of Statistics that showed that developer sales proceeds amounted to RMB 10.6 trillion in the first eight months of 2018, of which 33 percent, or RMB 3.5 trillion, came from down-payments and other buyer funding. “If we removed the (pre-sales) system, it would reduce developers’ cash inflow by 33 percent. And if the new policy was released in the already under-supplied major cities, it would inevitably increase demand there,” Ouyang said.

China introduced its property pre-sale system in 1994 with the intention to shorten the cash cycle of the real estate industry. The system eased the developers’ financial needs and expedited turnover.

Pre-Sales System Has Helped Developers Build More Homes

Country Garden’s rise to the nation’s biggest developer by sales from seventh within two years highlights how the pre-sales system can fuel growth. It takes just 9.6 months on average under the current system for the builder to pay off the cost of its land purchases, according to a Bloomberg report, quoting a Country Garden investor presentation for fiscal 2017.

Eliminating pre-sales would fit President Xi Jinping’s exhortation at last year’s party congress that homes are not for speculation, but living, said Yan Yuejin, a property analyst at China Real Estate Information Corp. The industry analyst suggested a trial run of the new policy in selected cities first before evaluating the potential of total cancellation.

Mainland authorities first attempted to curb pre-sales in 2016 when Shenzhen sold its first parcel of land carrying a requirement that only finished properties could be sold. Shenzhen’s Urban Planning, Land & Resources Commission officially hailed the exemplary act as an “exploration” of the pre-sale system reform, although it was not successfully adopted by any other Chinese cities.

Housing Policy Crackdown Continues

Guangdong’s proposal is seen as yet another sign of Beijing’s determination to impose even tighter restrictions on the real estate market. The central government went all out during the first half of 2018 to cool an overheated real estate market by limiting the number of properties one can purchase and sell, raising the minimum down-payment ratio for homebuyers and boosting the time period between a purchase and when a unit can be then listed on the market for resale. Regulators also took the measures to tighten credit and force the developers to slow down their sales growth.

Despite the effort, new-home prices rose at the fastest pace in 22 months in July, climbing 1.2 percent from the previous month, according to Bloomberg. The jump in values in third-tier cities was the biggest increase recording in data going back to 2009. The government is likely to roll out more housing curbs, although it still faces the dilemma of attempting to restrain prices without tanking the property sector during a broader economic slowdown.